NEW YORK-“In its 93rd month of expansion, the U.S. economy may be more vulnerable
going into 1999 than at any time since 1994 when the Federal Reserve (Board) last tightened significantly,” Peter
M. Donovan said in a recent presentation about the outlook for the capital markets.
“What is different from
1994 is that the Fed is now on the side of the angels, doing its part to insulate the United States from Asia’s financial
crisis and extend the economic expansion.”
Donovan, who addressed the New York Society of Security
Analysts, is president and chief executive officer of Wright Investors’ Service, a Bridgeport, Conn., money
management firm that conducts ongoing research into about 20,000 companies worldwide.
He said he is optimistic
the United States will sidestep a recession in 1999, largely due to the Fed’s intervention. However, a slowdown in
economic growth seems unavoidable.
“Outside of Asia, Latin America and emerging markets generally, 1998
was-like 1997, 1996 and 1995-another reasonably solid year for the global financial markets. Since 1994, Europe and
the United States have each averaged around a 25 percent annual rate of investment return, an incredible achievement
in the midst of Asia’s turmoil,” Donovan said. “It may not be reasonable to expect another encore from an
aging superstar bull market in 1999.”
A year ago, Wright forecasted the Dow Jones Industrial Average would
peak at 8600 during 1998.
“It has done quite a bit better than that, and while we did get the expected
correction, it wasn’t as broad or as lasting as we anticipated. The Dow may make it to 10,000 sometime in the coming
year, but I believe the market will have a hard time holding above that level,” Donovan said.
“For the
first time since 1994, stocks will be hard-pressed to deliver a double-digit return in 1999. In fact, negative returns from
equities may be more likely.”
Furthermore, investors will focus more attention on uncertainties surrounding
the advent of the Euro and industry compliance with Year 2000 computer programming requirements as these concerns
“move out of the realm of speculation into reality.”
Overall, corporate profits fell 6 percent during the
third quarter of 1998, compared with the same period a year earlier. This was the largest such drop since 1989. When
year-end reports are in, Wright expects earnings of S&P 500 companies to “show little if any growth over 1997’s
total,” Donovan said.
In 1999, fierce competition will continue to limit the ability of companies to raise prices,
thereby causing profits to remain flat or possibly to decline. Additionally, American consumers spent more than their
income during the last two months of 1998, setting the stage for restrained spending in coming months. In fact, the
personal savings rate is at its lowest since the 1930s.
“Longer term, Wall Street estimates of corporate profit
growth at 15 percent per year appear out of touch with reality. The five years ended in 1997 saw profits grow on that
order, but that was a lot easier to achieve coming off the low profit rates of 1991-1992 than from today’s levels of
profitability,” Donovan said.
“Sales, the most basic of corporate fundamentals, are not growing at
anywhere near historical rates.”
At the same time, stock price/earnings ratios-the price of a stock divided by
its earnings per share-were higher at the close of 1998 than at any time since the period of 1929 to 1931. Mergers and
acquisitions for the year took place in record numbers and amounts. The volume of initial public offerings also was
generally heavy.
“So, if the new paradigm is more hype and rationalization than fact, equity investors,
particularly those who have piled into the big-cap leaders at the top of the S&P 500, have taken on some pretty
substantial risks [in 1998],” Donovan said.
The S&P Top 50 includes Microsoft Corp., Lucent Technologies
Inc., Cisco Systems and MCI WorldCom.
Outside the S&P 500, many high-profit, high-growth stocks experienced
a “wrenching bear market” in 1998, and they have a long way to go to recover from that, Donovan
said.
“The high-priced nifty 50 (at the top of the S&P 500) will almost certainly underperform. In my view,
high-quality stocks and bonds purchased at reasonable prices still offer investors the best opportunity for achieving
inflation beating returns,” he said.
“Returns for the next several years probably will trail the
extraordinary rates of the past decade and a half … [However,] in the new millennium, we can look forward to renewed
growth, healthy competition, technological innovation and low inflation, all factors that should favor financial
assets.”
